Financial brush fires flaring up globally

Commentary: Global infernos create danger and opportunity

By

JohnNyaradi

BEND, Ore. (MarketWatch) — It’s fire season in our country’s forests, and, in the financial markets, hot spots have flared up across Europe, Asia and the United States. As we move into the hot days of July, governments and central bankers around the world are scrambling like desperate fire fighters to contain blazes that threaten the global economy.

Hot spots to watch

Europe: Europe continues to smolder, as the Greek crisis just doesn’t seem to go away. After last week’s settlements, major ratings agencies now say that the planned voluntary “rollover” of Greek debt could indeed be a default, which could create a major headache for the European Central Bank and other sovereign and banking players with wide exposure to the region.

Beyond Greece, smoke drifts across Europe from other ignition sources. Retail sales in the euro zone dropped by 1.1% in May, more than expected, while a gauge of the European Union’s service sector fell to an eight-month low. Italy’s services PMI dropped into contraction range, with a print of 47.4, missing expectations, while France and Germany also reported declining PMIs.

China: The world’s second-largest economy has slowed markedly, with its May PMI falling to 50.9 from 52 as multiple interest-rate hikes start to take hold. With 50 considered to be the demarcation line between growth and contraction, this global giant stands perilously close to the brink of economic decline. The Shanghai Composite (000001) has taken note of this possibility and is now down nearly 10% from its April peak and is well below its 200-day moving average. Everyone expects the dragon to be the engine of global economic growth, but, with current problems growing and the possibility of a hard landing becoming more pronounced, one can safely conclude that this bonfire could swiftly hopscotch the world.

United States: Flames popping up around the U.S. are hot and wide, and everywhere we look we see a frenzied scramble for containment.

Budget negotiations remain at center stage as the White House and Congress battle to find a solution by Aug. 2, and some reports indicate that a settlement needs to be reached by mid-July to allow for passage in time to meet the deadline. This standoff will likely lead to some kind of eleventh-hour, short-term settlement (or not), but, in either case, nobody can know how markets will react to anything less than a long-term commitment to getting the U.S. fiscal house in order.

Budget blazes also hit the state level last week as Minnesota shut down most of its government and laid off more than 20,000 workers just in time for the 4th of July weekend. This will likely have a ripple effect in the private economy and could be the harbinger of more flare-ups as multiple states and municipalities deal with yawning budget gaps.

As the Federal Reserve’s bond-buying program came to an end last week, the Treasurys market was crushed, with the 10-year note falling for five straight days. Bond-auction demand was weak, and so yields, of course, had to rise. With the Fed now moving to “QE Lite,” simply repurchasing assets as they mature, everyone is wondering who will replace the Fed in the marketplace.

Overall, the Fed has been soaking up as much as 70% of supply, and, without another major buyer, many analysts suggest that a hike in interest rates is sure to follow. Of course, rising interest rates could be highly combustible for a country that’s $14 trillion in debt.

Hot spots create danger and opportunity

Europe: If Europe continues to burn, you can consider “shorting” the Continent and its common currency with ProShares Ultra Short Euro
EUO, +0.78%
or ProShares Short MSCI EAFE (Europe, Australasia, Far East)
EFZ, +1.26%
which offers exposure to developed nations excluding the U.S. and Canada.

China: Inverse ETFs offer the opportunity to “short” the Chinese markets, and the most widely known is ProShares Ultra Short FTSE China 25
FXP, +3.82%
Also, ETF investors can find “1x” short exposure to China with ProShares Short FTSE China 25
YXI, +1.49%
which is a relatively new and still thinly traded ETF from the ProShares family.

United States: In U.S. markets, potential opportunities abound for ETF investors seeking profits should any of today’s brush fires flare into conflagrations.

The biggest looming inferno is the U.S. Treasury market, as the Fed exits a large portion of its quantitative-easing policy. Budgetary pressures and the law of supply and demand could lead to rising interest rates, and in that case, ProShares UltraShort 20+ Year Treasury
TBT, -1.39%
could be a good place to be.

In the unlikely event of a U.S. default on its debt this month or next, SPDR Gold Shares
GLD, +0.51%
would be widely viewed as the ultimate safe haven. While GLD has recently been in a slight correction, many analysts forecast a prolonged bull market for the “barbarous relic” as both individual investors and institutions lose faith in sovereign powers and their currencies. GLD is the second-largest ETF, behind only the SPDR S&P 500 ETF Trust
SPY, -1.56%
and, with more than $57 billion under management, GLD’s newer investors will have plenty of company.

So as we face summer’s hottest days, brush fires crackle around the world, and ETF investors are faced with both danger and opportunity. Governments and bankers will try to douse the blazes, but, no matter the outcome of these efforts, the power and flexibility of exchange traded funds can offer investors an ETF edge.

John
Nyaradi

John Nyaradi publishes Wall Street Sector Selector (www.wallstreetsectorselector.com), which provides news, analysis and strategies for trading exchange-traded funds. He's also the author of "Super Sectors: How To Outsmart the Market Using Sector Rotation and ETFs."

MarketWatch Partner Center

John
Nyaradi

John Nyaradi publishes Wall Street Sector Selector (www.wallstreetsectorselector.com), which provides news, analysis and strategies for trading exchange-traded funds. He's also the author of "Super Sectors: How To Outsmart the Market Using Sector Rotation and ETFs."

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information.
All quotes are in local exchange time. Real-time last sale data for U.S. stock quotes reflect trades reported through Nasdaq only.
Intraday data delayed at least 15 minutes or per exchange requirements.